Overnight, one of our favorite hedge fund commentators, (ex) IceFarm Capital’s Michael Green, was gruesomely entertained by Ken Rogoff’s WSJ Op-Ed, pushing for a ban on $20, $50 and $100 bills, to which he – just like us – has some less than kind words.
Unlike our bemused conclusion about the idiocy of Rogoff’s latest pitch to do away with cash (something we predicted would happen years ago as banning cash is a necessary, if not sufficient, condition for NIRP to work), Green provides the following thought experiment to demonstrate just how ridiculous economic prescriptions have become:
“Ken wants even more powerful monetary policy ability to pursue negative rates – because they are doing such a bang up job in Japan and Europe – or at least they would be if it weren’t for that pesky reality of cash. Like many Keynesian proposals, however, this ridiculous love affair is predicated on a very simple concept – lower interest rates equals more borrowing and therefore economic growth. A simple thought experiment suffices to prove this fallacy. Imagine the government sets a -100% rate to “stimulate” growth. Almost immediately, all economic activity would cease. Payments would go unaccepted, checks would be refused, loanable funds would evaporate. Yes, there would be an initial burst of economic activity as “savers” fled from currency, but move to the second economic period… what happens next? Do banks lend money? They would like to… but who would take the electronic deposit that needed to be spent immediately with no one willing to accept it? It’s an absurd scenario, but it illustrates the primary issue with negative rates – under a negative rate scenario, the only participant receiving more cash over time is the government. The private sector slowly collapses as we are seeing in Japan and Europe in real time.
Green then confirms something else we have said for years, namely that “the Keynesian model of banking is simply wrong.”
Banks are not constrained by either cash or reserves – both are easily available in ordinary times and in fact modern research into the credit creation process reveals that neither is viewed as a constraint. Using the equivalent of the medical technique of tagging radioactive isotopes for cancer research, Richard Werner presented empirical studies on this subject in 2014
This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money ‘out of nothing’ and does so when it extends credit (the credit creation theory of banking). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust’ produced by the banks individually, “out of thin air”.
Richard Werner, International Review of Financial Analysis
So while banning cash is necessary for NIRP, NIRP in itself – as well as the Keynesian model in general – are flawed, something which is increasingly obvious to all, and thus eliminating paper currency will do nothing more than push more to buy precious metals.
There is, however, another more important observation which Green makes: as he says, “there is no coincidence between Rogoff’s proposals and the Google nGram of Benjamin Franklin’s quote on liberty”
“Those who would give up essential Liberty, to purchase a little temporary Safety, deserve neither Liberty nor Safety.” – Benjamin Franklin
A Whiskey Rebellion
B War of 1812
C Patriot War (vs Canada)
D Civil War
E Indian Wars
F Spanish-American War
G World War II
H War on “Terror”
Which brings us to Green’s startling conclusion: we may have reached that point in history, where rebellion – due to government incursion into private liberty – is once again inevitable. To wit: “We are at a point where the encroachment of government power, whether foreign or domestic, has historically resulted in some form of a rebellion against said power.”
Sometimes those are futile (Whiskey Rebellion, Patriot War, Civil War), other times those are successful. Regardless, they are costly. It is likely not a coincidence that economic booms (mid 1820s, 1850s [driven by gold rush in California], 1920s and 1990s] resulted in little interest in libertarian slogans, while periods with high utility for Franklin’s quote match up well with military activity. Rogoff is approaching this period from the perspective that governments are being “deprived of tax revenues” that could be used to drive further economic growth if utilized by governments to repay debts; the “correct” approach is to view negative rates as a tax on the private sector to fund the public sector. Until this second view is embraced (which I would not count on any time soon), we should expect more proposals of this nature – and eventually their embrace by madmen in authority:
“Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back”
– John Maynard Keynes
Incidentally, if anyone is tired of holding physical cash, Green has a modest proposal: “as an alternative to negative rates or the abolition of cash, on the Ice Farm we have instituted the world’s first storage facility for unwanted $100 bills – please feel free to donate your unwanted large denomination cash.”
* * *